PMRT Arises Due to Failure to Respect Trust Formalities

United States v. Tingey, (10th Cir., May 29, 2013) illustrates the importance of respecting trust formalities. In 1993, Douglas Brown created an irrevocable trust for the benefit of his wife and children, and Robert Tingey was named as the trustee. At approximately the same time as the creation of the trust, Douglas and his wife negotiated the purchase of a ski cabin located in Utah. At the conclusion of the negotiations, the sellers conveyed title to the cabin to the trust. Douglas paid the down payment on the cabin using his personal funds, and the remainder of the purchase price was to be paid off in accordance with a promissory note in favor of the sellers. Douglas was initially listed as the sole obligor on this note, but soon after the closing a replacement promissory note was executed listing both Douglas and the trust as the obligors.

While the trust held title to the property, the Browns regularly used the ski cabin without obtaining Robert’s permission. The Browns also performed maintenance on the cabin, paid the utility bills and insurance premiums and even leased the cabin to a friend without Robert’s knowledge. The homeowner’s insurance policy was issued in Douglas’ name, rather than the trust’s name. Robert never performed any maintenance on the cabin, and he knew little about how the Browns used the property. Further, the promissory note was paid off through a number of sources, including rental payments from the friend, payments directly from the Browns, payments from Douglas’ business and a number of other sources closely connected to Douglas.

Beginning sometime around 1993, the Browns began to experience serious financial difficulties. Investors in Douglas’ business sued him in 1994, and a criminal securities fraud case was also brought against him. Further, the Browns owed over $2, million in federal taxes, and the federal government issued tax liens regarding these unpaid taxes.

District Court Proceedings

In 2007, the government filed a complaint against the trust in the U. S. District Court for the District of Utah in part to foreclose on these tax liens on the ski cabin, arguing that the trust held the ski cabin as a nominee for the Browns. The Internal Revenue Service may impose tax liens on any property or rights to property owned by a taxpayer, including any property owned by a third party as a nominee for the taxpayer, to satisfy his tax deficiency. Under this nominee theory, a taxpayer is found to be the ultimate owner of property if he “has engaged in a legal fiction by placing legal title to property in the hands of a third party while actually retaining some or all of the benefits of true ownership.” Holman v. United States, 505 F.3d 1060, 1065 (10th Cir. 2007). When applying the nominee theory, courts consider: (1) whether the taxpayer has rights to the property in question under state law, and (2) whether the taxpayer’s state rights qualify as “property” or “rights to property” under federal tax law. Drye v. United States, 528 U.S. 49, 58 (1999).

The district court found that under Utah law, the trust held legal title to the cabin for the Browns’ benefit in a purchase money resulting trust (PMRT), and thus, the Browns held the beneficial interest in the cabin. In addition, the district court determined that under federal law the trust held the cabin as a nominee for the Browns. Thus, the district court held that the government could foreclose on the Browns’ tax liens on the ski cabin. Robert appealed this decision, arguing, in part, that the court erroneously concluded that a PMRT was created under Utah law.

PMRTs Under Utah Law

Under Utah law, a PMRT is established when one person pays the purchase price for property but title to the property is transferred to another. In this situation, the law presumes that the person who paid the purchase price intended to retain the property, and thus, a PMRT arises in favor of this individual. One exception to this rule applies when the transferee is the wife, child or other natural object of bounty of the payor, unless the payor “manifests an intention that the transferee should not have the beneficial interest in the property.” Zion’s First Nat’l Bank v. Fenmore, 655 P.2d 1111, 1114 (Utah 1982) (citing Restatement (Second) of Trusts, Sections 442, 433). Evidence indicating the payor’s intent to retain the property includes: (1) circumstances indicating that the payor has a reason for the property to be titled in the name of another, and (2) the payor asserts ownership of the property by, for example, managing the property, collecting rents, and paying expenses related to the property. Importantly for those of us who practice outside the state of Utah, Utah generally follows the approach provided in the Restatement (Second) of Trusts regarding PMRTs.

Robert first argued that the trust, not Douglas, paid the purchase price for the ski cabin and therefore a PMRT couldn’t have been created. The district court had determined that while the trust made some payments on the promissory note, most of the payments came from Douglas, his business or other sources directly connected to him. The U.S. Court of Appeals for the Tenth Circuit held that under these facts, the district court’s ruling that Douglas, not the trust, paid for the cabin wasn’t clearly erroneous.

Robert also claimed that, even if Douglas paid the purchase price for the cabin, the evidence presented didn’t establish a PMRT. The district court had held that the evidence showed that Douglas intended to retain the beneficial interest in the ski cabin. Specifically, Douglas managed the property himself, disregarded trust formalities and essentially left the trustee in the dark. In addition, payments on the note were made from sources closely connected to Douglas, he rented out the cabin to a friend without informing the trustee and he paid the cabin’s maintenance, utility and insurance expenses. Given these facts, the Tenth Circuit held that the district court demonstrated that Douglas intended to retain the beneficial interest in the ski cabin by clear and convincing evidence and that the district court’s holding wasn’t clearly erroneous.

The Tenth Circuit also held that the district court reasonably concluded that Douglas created the trust to shield his assets from his creditors. The court noted that an intrafamilial transfer shouldn’t automatically result in a PMRT, especially if the evidence shows that the reason for such transfer was to accomplish various estate planning objectives. However, the district court didn’t find that the ski cabin was placed in the trust for estate planning purposes; in particular, Robert testified that he understood Douglas’ purpose for establishing the trust was to protect his assets from his creditors. This testimony suggested to the court that Douglas considered the assets held in the trust to be his own, rather than the beneficiaries’. Therefore, the Tenth Circuit held that the district court’s finding that the transfer of the cabin to the trust wasn’t based out of familial affection, but instead was to shelter Douglas’ assets from claims of his creditors, wasn’t clearly erroneous. In a dissenting opinion, one of the justices stated that the evidence here was ambiguous as to Douglas’ intentions. Further, the dissent recognized that many taxpayers establish trusts to both obtain creditor protection and accomplish estate planning objectives and concluded that the majority shouldn’t have deferred to the district court’s finding on this point.

Property Held in an Express Trust

Finally, Robert argued that a PMRT can’t be created when an express trust holds title to the property. The Tenth Circuit disagreed, holding that “[n]o rule of human nature precludes the possibility that someone would purchase property to be held in the name of a trust while intending that the purchaser retain the beneficial interest, any more than it precludes a purchaser from transferring title to another person while intending that the purchaser retain the beneficial interest.” The court noted that a PMRT would be established under the Restatement (Second) of Trusts if a taxpayer didn’t wish for others to know that he was purchasing the property, and one possible way to conceal this information is to hold the property in an express trust. Thus, the court affirmed the district court’s decision and held that the government could foreclose on the tax liens on the ski cabin.

Lessons Learned

This case demonstrates the importance of respecting the formalities of an irrevocable trust. In particular, the trust, rather than Douglas, should have covered the expenses and promissory note payments. In addition, the trust, rather than Douglas, should have been responsible for renting the cabin to a third party, and the insurance policy should have been issued in the name of the trust. Finally, Douglas should have kept the trustee informed as to their use of the cabin. By not adhering to these important formalities, it was clear to the court that Douglas “had as much control of the property as he would have had if it had been in his own name.” Therefore, it’s essential that property held by an irrevocable trust must be managed and controlled by the trustee, rather than the trust beneficiaries and their families.